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Innovation and competitive pressure

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The author analyzes the effects of competition on RandD effort (in a non-tournament context) and obtains robust results that hold for a variety of market structures, including markets with and without barriers to entry and markets characterized by either price or quantity competition. The approach encompasses models of direct investment to reduce costs as well as models where cost reduction arises because the agency problem between managers and owners in an asymmetric information context (X-inefficiency) is better resolved. It is found that increasing the number of firms tends to reduce RandD effort, whereas increasing the degree of product substitutability, with or without free entry, increases RandD effort-provided that the total market for varieties does not shrink. Increasing the total market size increases both RandD effort and (weakly) the number of varieties.

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